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mcc19359_ch17_308-324 10/17/2003 10:52AM Page 308 17 Economic Growth The world’s capitalist countries experienced impressive growth of real GDP and real GDP per capita during the last half of the twentieth century. In the United States, real GDP increased by 450 percent between 1950 and 2000, while population increased by only 80 percent. In 2000 the value of goods and services available to the average U.S. resident was three times greater than that of 50 years earlier. This expansion of real output—this economic growth—greatly increased material abundance and lifted the standard of living of most Americans. In Chapter 8 we explained how economic growth is measured, briefly looked at economic growth in the United States, and compared growth rates among the major nations. In this chapter we want to explore economic growth in much greater depth.Then in Bonus Web Chapter 39W we extend the discussion of economic growth to the developing nations. Ingredients of Growth There are six main ingredients in economic growth. We can group them as supply, demand, and efficiency factors. Supply Factors Four of the ingredients of economic growth relate to the physical ability of the economy to expand. They are: • Increases in the quantity and quality of natural resources. • Increases in the quantity and quality of human resources. • Increases in the supply (or stock) of capital goods. • Improvements in technology. 308 These supply factors—changes in the physical and technical agents of production—enable an economy to expand its potential GDP. Demand Factor The fifth ingredient of economic growth is the demand factor: • To achieve the higher production potential created by the supply factors, households, businesses, and government must purchase the economy’s expanding output of goods and services. When that occurs, there will be no unplanned increases in inventories and resources will remain fully employed. Economic growth requires increases in total spending to mcc19359_ch17_308-324 28/08/03 18:40 Page 309 CHAPTER Efficiency Factor The sixth ingredient of economic growth is the efficiency factor: • To reach its production potential, an economy must achieve economic efficiency as well as full employment. The economy must use its resources in the least costly way (productive efficiency) to produce the specific mix of goods and services that maximizes people’s well-being (allocative efficiency). The ability to expand production, together with the full use of available resources, is not sufficient for achieving maximum possible growth. Also required is the efficient use of those resources. FIGURE 309 17.1 Economic growth and the production possibilities curve. Economic growth is made possible by the four supply factors that shift the production possibilities curve outward, as from AB to CD. Economic growth is realized when the demand factor and the efficiency factor move the economy from point a to b. C Capital goods realize the output gains made available by increased production capacity. 17 | Economic Growth A c b Economic growth a The supply, demand, and efficiency factors in economic growth are related. Unemployment caused by insufficient total spending (the demand factor) may lower the rate of new capital accumulation (a supply factor) and delay expenditures on research (also a supply factor). Conversely, low spending on investment (a supply factor) may cause insufficient spending (the demand factor) and unemployment. Widespread inefficiency in the use of resources (the efficiency factor) may translate into higher costs of goods and services and thus lower profits, which in turn may slow innovation and reduce the accumulation of capital (supply factors). Economic growth is a dynamic process in which the supply, demand, and efficiency factors all interact. Production Possibilities Analysis To put the six factors underlying economic growth in proper perspective, let’s first use the production possibilities analysis introduced in Chapter 2. Growth and Production Possibilities Recall that a curve like AB in Figure 17.1 is a production possibilities curve. It indicates the various maximum combinations of products an economy can produce with its fixed quantity and quality of natural, human, and capital resources and its stock of technological knowledge. An improvement in any of the supply factors will push the production possibilities curve outward, as from AB to CD. But the demand factor reminds us that an increase in total spending is needed to move the economy from point a to a point on CD. And the efficiency factor reminds us that we need least-cost production and an optimal location on CD for the resources to make their maximum possible dollar 0 B D Consumer goods contribution to total output. You will recall from Chapter 2 that this “best allocation” is determined by expanding production of each good until its marginal benefit equals its marginal cost. Here, we assume that this optimal combination of capital and consumer goods occurs at point b. Example: The net increase in the size of the labor force in the United States in recent years has been 1.5 to 2 million workers per year. That increment raises the economy’s production capacity. But obtaining the extra output that these added workers could produce depends on their success in finding jobs. It also depends on whether or not the jobs are in firms and industries where the workers’ talents are fully and optimally used. Society does not want new labor-force entrants to be unemployed. Nor does it want pediatricians working as plumbers or pediatricians producing services for which marginal costs exceed marginal benefits. Normally, increases in total spending match increases in production capacity, and the economy moves from a point on the previous production possibilities curve to a point on the expanded curve. Moreover, the competitive market system tends to drive the economy toward productive and allocative efficiency. Occasionally, however, the curve may shift outward but leave the economy behind at some level of operation such as c in Figure 17.1. Because c is inside the new production possibilities curve CD, the economy has not realized its potential for economic growth. (Key Question 1) mcc19359_ch17_308-324 10/17/2003 10:52AM Page 310 310 PA R T FIVE | Long-Run Perspectives and Macroeconomic Debates Labor and Productivity Although demand and efficiency factors are important, discussions of economic growth focus primarily on supply factors. Society can increase its real output and income in two fundamental ways: (1) by increasing its inputs of resources, and (2) by raising the productivity of those inputs. Figure 17.2 concentrates on the input of labor and provides a useful framework for discussing the role of supply factors in growth. A nation’s real GDP in any year depends on the input of labor (measured in hours of work) multiplied by labor productivity (measured as real output per hour of work): Real GDP hours of work labor productivity So, thought of this way, a nation’s economic growth from one year to the next depends on its increase in labor inputs (if any) and its increase in labor productivity (if any). Illustration: Assume that the hypothetical economy of Ziam has 10 workers in year 1, each working 2000 hours per year (50 weeks at 40 hours per week). The total input of labor therefore is 20,000 hours. If productivity (average real output per hour of work) is $10, then real GDP in Ziam will be $200,000 ( 20,000 $10). If work hours rise to 20,200 and labor productivity rises to $10.40, Ziam’s real GDP will increase to $210,080 in year 2. Ziam’s rate of economic growth will be about 5 percent [ ($210,080 $200,000)$200,000] for the year. Hours of Work What determines the number of hours worked each year? As shown in Figure 17.2, the FIGURE 17.2 The supply determinants of real output. Real GDP is usefully viewed as the product of the quantity of labor inputs (hours of work) multiplied by labor productivity. • Size of employed labor force • Average hours of work Labor inputs (hours of work) ⴛ • Technological advance • Quantity of capital • Education and training • Allocative efficiency • Other ⴝ Labor productivity (average output per hour) Real GDP hours of labor input depend on the size of the employed labor force and the length of the average workweek. Labor-force size depends on the size of the working-age population and the labor-force participation rate—the percentage of the working-age population actually in the labor force. The length of the average workweek is governed by legal and institutional considerations and by collective bargaining. Labor Productivity Figure 17.2 tells us that labor productivity is determined by technological progress, the quantity of capital goods available to workers, the quality of the labor itself, and the efficiency with which inputs are allocated, combined, and managed. Productivity rises when the health, training, education, and motivation of workers improve, when workers have more and better machinery and natural resources with which to work, when production is better organized and managed, and when labor is reallocated from less efficient industries to more efficient industries. Growth in the AD-AS Model Let’s now link the production possibilities analysis to longrun aggregate supply so that we can show the process of economic growth through the extended aggregate demand–aggregate supply model developed in Chapter 16. Production Possibilities and Aggregate Supply The supply factors that shift the economy’s production possibilities curve outward also shift its long-run aggregate supply curve rightward. As shown in Figure 17.3, the outward shift of the production possibilities curve from AB to CD in graph (a) is equivalent to the rightward shift of the economy’s long-run aggregate supply curve from ASLR1 to ASLR2 in graph (b). The long-run AS curves are vertical because an economy’s potential output—its full-employment output—is determined by the supply and efficiency factors, not by its price level. Whatever the price level, the economy’s potential output remains the same. Moreover, just as price-level changes do not shift an economy’s production possibilities curve, they do not shift an economy’s long-run aggregate supply curve. Extended AD-AS Model In Figure 17.4 we use the extended aggregate demand–aggregate supply model to depict the economic growth process. (The model is extended to include the distinction between short- and longrun aggregate supply. See Chapter 16.) Suppose that an economy’s aggregate demand curve, long-run aggregate supply curve, and short-run aggregate mcc19359_ch17_308-324 28/08/03 18:40 Page 311 CHAPTER FIGURE 17 | Economic Growth 311 17.3 Production possibilities and long-run aggregate supply. (a) Supply factors shift an economy’s production possibilities curve outward, as from AB to CD. (b) The same factors (along with the efficiency factor) shift the economy’s long-run aggregate supply curve to the right, as from ASLR1 to ASLR2. ASLR1 ASLR2 A 0 Price level Capital goods C B D Consumer goods (a) Increase in production possibilities 0 supply curve initially are AD1, ASLR1, and AS1, as shown. The equilibrium price level and level of real output are P1 and Q1. At price level P1, the short-run aggregate supply is AS1; it slopes upward because, in the short run, changes in the price level cause firms to adjust their output. In the long run, however, price-level changes do not affect the Q1 Q2 Real GDP (b) Increase in long-run aggregate supply economy’s real output, leaving the long-run aggregate supply curve vertical at the economy’s potential level of output, here Q1. This potential level of output depends on the supply and efficiency factors previously discussed. Now let’s assume that changes in the supply factors (quantity and quality of resources and technology) shift FIGURE ASLR2 ASLR1 Economic growth in the extended AD-AS model. Long-run aggregate supply and short-run aggregate supply have increased over time, as from ASLR1 to ASLR2 and AS1 to AS2. Simultaneously, aggregate demand has shifted rightward, as from AD1 to AD2. The actual outcome of these combined shifts has been economic growth, shown as the increase in real output from Q1 to Q2, accompanied by mild inflation, shown as the rise in the price level from P1 to P2. AS2 Price level AS1 P2 P1 AD2 AD1 0 Q1 Q2 Real GDP 17.4 mcc19359_ch17_308-324 10/17/2003 10:52AM Page 312 PA R T FIVE | Long-Run Perspectives and Macroeconomic Debates the long-run aggregate supply curve rightward from ASLR1 to ASLR2. The economy’s potential output has increased, as reflected by the expansion of available real output from Q1 to Q2. If prices and wages are inflexible downward, the economy can realize its greater production potential only through an increase in aggregate demand. Under usual circumstances, such an increase is forthcoming because the production of additional output produces additional income to households and businesses. In Figure 17.4, suppose that this additional income results in increases in consumption and investment spending such that the aggregate demand curve shifts from AD1 to AD2. Also suppose that the economy continues to use its resources efficiently. The increases of aggregate supply and aggregate demand in Figure 17.4 have increased real output from Q1 to Q2 and have boosted the price level from P1 to P2. At the higher price level P2, the economy confronts a new short-run aggregate supply curve AS2. The result of the dynamics described in Figure 17.4 is economic growth, accompanied in this case by mild inflation. In brief, economic growth results from increases in aggregate supply and aggregate demand. Whether zero, mild, or rapid inflation accompanies 17.1 Growth economic growth depends on the extheory tent to which aggregate demand increases relative to aggregate supply. (Key Question 5) U.S. Economic Growth Rates Figure 17.5 shows the average annual growth rates of real GDP and real per capita GDP in the United States for the past five decades. Over the full 50 years, real GDP grew by about 3.5 percent annually, whereas real GDP per capita grew by about 2.3 percent annually. Economic growth was particularly strong in the 1960s but declined during the 1970s and 1980s. Although the average annual growth rate for the 1990s only slightly exceeded that of the 1980s, real GDP surged between 1996 and 1999. Specifically, it grew by 3.6 percent in 1996, 4.4 percent in 1997, 4.3 percent in 1998, and 4.1 percent in 1999. These growth rates were not only higher than previous rates in the 1990s but higher than those in most other advanced industrial nations during that period. Growth continued strong in 2000 in the United States, but it collapsed during the recessionary year 2001. Specifically, the rate was 3.8 percent in 2000 and 0.3 percent in 2001. In 2002 the U.S. growth rate was 2.3 percent. Q U I C K R E V I E W 17.1 • The ingredients of economic growth include (a) four supply factors (increases in the quantity and quality of natural resources, increases in the quantity and quality of human resources, increases in the stock of capital goods, and improvements in technology), (b) a demand factor (increased total spending), and (c) an efficiency factor (achieving economic efficiency). • Economic growth is shown as an outward shift of a nation’s production possibilities curve (accompanied by movement from some point on the old curve to a point on the new curve) and combined rightward shifts of the longrun aggregate supply curve, the short-run aggregate supply curve, and the aggregate demand curve. • Real GDP grew by an average of 3.5 percent annually between 1950 and 2000; over that same period, real GDP per capita grew at an average annual rate of about 2.3 percent. Accounting for Growth The Council of Economic Advisers uses growth accounting—the bookkeeping of the supply-side elements that contribute to changes in real GDP—to assess FIGURE 17.5 U.S. economic growth, annual averages for five decades. Growth of real GDP has averaged about 3.5 percent annually in the last halfcentury, and annual growth of real GDP per capita averaged about 2.3 percent. Growth rates in the 1970s and 1980s were less than those in the 1960s, but the rates rebounded in the last half of the 1990s. Source: Bureau of Economic Analysis, www.bea.gov/. 5 Average annual increase (percent) 312 Real GDP Real GDP per capita 4 3 2 1 0 1950–1959 1960–1969 1970–1979 Year 1980–1989 1990–1999 mcc19359_ch17_308-324 10/17/2003 19:08PM Page 313 CHAPTER CONSIDER THIS . . . Economic Growth Rates Matter! When compounded over many decades, small absolute differences in rates of economic growth add up to substantial differences in real GDP and standards © Dennis O’Clair/Getty of living. Consider three hypothetical Images countries—Alpha, Bravo, and Charlie. Suppose that in 2003 these countries have identical levels of real GDP ($6 trillion), population (200 million), and real GDP per capita ($30,000). Also, assume that annual real GDP growth is 2 percent in Alpha, 3 percent in Bravo, and 4 percent in Charlie. How will these alternative growth rates affect real GDP and real GDP per capita over a long period, say, the 70-year average life span of an American? By 2073 the 2, 3, and 4 percent growth rates would boost real GDP from $6 trillion to: • $24 trillion in Alpha. • $47 trillion in Bravo. • $93 trillion in Charlie. For illustration, let’s assume that each country experienced an average annual population growth of 1 percent over the 70 years.Then, in 2073 real GDP per capita would be about: • $60,000 in Alpha. • $118,000 in Bravo. • $233,000 in Charlie. Economic growth rates matter! the factors underlying economic growth. Ultimately, that accounting leads to two main categories: • Increases in hours of work. • Increases in labor productivity. Labor Inputs versus Productivity Table 17.1 provides the relevant data for four periods. The symbol “Q” in the table stands for “quarter” of the year. The end points for the first three periods are TA B L E 17 | Economic Growth business-cycle peaks, and the last period includes future projections by the Council of Economic Advisers. It is clear from the table that both increases in the quantity of labor and rises in labor productivity are important sources of economic growth. Between 1960 and 2002, the labor force increased from 70 million to 143 million workers. Over that period the length of the workweek remained relatively stable. Falling birthrates slowed the growth of the native population, but increased immigration partly offset that slowdown. Of particular significance was a surge of women’s participation in the labor force (see this chapter’s Last Word). Partly because of that increased participation, U.S. labor-force growth averaged 1.7 million workers per year during the past 25 years. The growth of labor productivity has also been important to economic growth. In fact, productivity growth has usually been the more significant factor, with the exception of 1973–1990 when productivity growth greatly slowed. For example, between 1990 and 2002, productivity growth was responsible for 2 percentage points, or 68 percent, of the 3 percent average annual economic growth. Over the 2002–2008 period, productivity growth is projected to account for 56 percent of the growth of real GDP. Technological Advance The importance of productivity growth to economic growth calls for a fuller explanation of the factors that contribute to productivity growth. The largest contributor is technological advance, which is thought to account for about 40 percent of productivity growth. As economist Paul Romer stated, “Human history teaches us that economic growth springs from better recipes, not just from more cooking.” Technological advance includes not only innovative production techniques but new managerial methods and new forms of business organization that improve the process of production. Generally, technological advance is generated by the discovery of new knowledge, which allows resources to be combined in improved ways that 17.1 Accounting for Growth of Real GDP, 1960–2008 (Average Annual Percentage Changes)* Item Increase in real GDP Increase in quantity of labor Increase in labor productivity 313 1960 Q2 to 1973 Q4 1973 Q4 to 1990 Q3 1990 Q3 to 2002 Q3 2002 Q3 to 2008 Q4 4.2 1.6 2.6 2.9 1.6 1.3 2.9 0.9 2.0 3.2 1.4 1.8 *Rates beyond 2002 are projected rates. Source: Derived from Economic Report of the President, 2003, p. 66. mcc19359_ch17_308-324 10/17/2003 10:52AM Page 314 PA R T FIVE | Long-Run Perspectives and Macroeconomic Debates increase output. Once discovered and implemented, new knowledge soon becomes available to entrepreneurs and firms at relatively low cost. Technological advance therefore eventually spreads through the entire economy, boosting productivity and economic growth. Technological advance and capital formation (investment) are closely related, since technological advance usually promotes investment in new machinery and equipment. In fact, technological advance is often embodied within new capital. For example, the purchase of new computers brings into industry speedier, more powerful computers that incorporate new technology. Technological advance has been both rapid and profound. Gas and diesel engines, conveyor belts, and assembly lines are significant developments of the past. So, too, are fuel-efficient commercial aircraft, integrated microcircuits, personal computers, xerography, and containerized shipping. More recently, technological advance has exploded, particularly in the areas of information technology such as wireless communications and the Internet. Other fertile areas of recent innovation are medicine and biotechnology. Quantity of Capital A second major contributor to productivity growth is increased capital, which explains roughly 30 percent of productivity growth. More and better plant and equipment make workers more productive. And a nation acquires more capital by saving some of its income and using that saving to invest in plant and equipment. Although some capital substitutes for labor, most capital is complementary to labor—it makes labor more productive. A key determinant of labor productivity is the amount of capital goods available per worker. If both the aggregate stock of capital goods and the size of the labor force increase over a given period, the individual worker is not necessarily better equipped and productivity will not necessarily rise. But the quantity of capital equipment available per U. S. worker has increased greatly over time. (In 2001 it was about $82,000 per worker.) Public investment in the U.S. infrastructure (highways and bridges, public transit systems, wastewater treatment facilities, water systems, airports, educational facilities, and so on) has also grown over the years. This public capital (infrastructure) complements private capital. Investments in new highways promote private investment in new factories and retail stores along their routes. Industrial parks developed by local governments attract manufacturing and distribution firms. Private investment in infrastructure also plays a large role in economic growth. One example is the tremendous growth of private capital relating to communications systems over the years. Education and Training Ben Franklin once said, “He that hath a trade hath an estate,” meaning that education and training contribute to a worker’s stock of human capital—the knowledge and skills that make a productive worker. Investment in human capital includes not only formal education but also on-the-job training. Like investment in physical capital, investment in human capital is an important means of increasing labor productivity and earnings. An estimated 15 percent of productivity growth owes to such investment in people’s education and skills. One measure of a nation’s quality of labor is its level of educational attainment. Figure 17.6 shows large gains in education attainment over the past several decades. In 1960 only 41 percent of the U.S. population age 25 or older had at least a high school education; and only 8 percent had a college or postcollege education. By 2000, those numbers had increased to 84 and 26 percent, respectively. Clearly, education has become accessible to more people in the United States during the recent past. But all is not upbeat with education in the United States. Many observers think that the quality of education in the United States has declined. Average scores on standardized college admission tests are lower than they were a few decades ago. U.S. students in science and mathematics do not do as well as students in many other nations (see Global Perspective 17.1). The United States has been producing fewer engineers and scientists, a problem that may trace back to inadequate training in math and science in FIGURE 17.6 Changes in the educational attainment of the U.S. adult population. The percentage of the U.S. adult population, age 25 or more, completing high school and college has been rising over recent decades. Source: U.S. Census Bureau, www.census.gov. 100 Percent of adult population 314 College graduates or more High school graduates or more 80 60 40 20 0 1950 1960 1970 1980 1990 2000 mcc19359_ch17_308-324 28/08/03 18:40 Page 315 CHAPTER elementary and high schools. And it is argued that on-thejob training programs (apprenticeship programs) in several European nations are superior to those in the United States. For these reasons, much recent public policy discussion and legislation has been directed toward improving the quality of the U.S. education and training system. 17 | Economic Growth 315 Economies of Scale and Resource Allocation Economies of scale and improved resource allocation are a third and fourth source of productivity growth, and together explain about 15 percent of productivity growth. Economies of Scale Reductions in per-unit cost that G L O B A L P E R S P E C T I V E 17.1 Average Test Scores of Eighth-Grade Students in Math and Science,Top 10 Countries and the United States The test performance of U.S. eighth-grade students did not rank favorably with that of eighth-graders in several other nations in the Third International Math and Science Study (1999). Mathematics Rank Score 1 Singapore 604 2 South Korea 587 3 Taiwan 585 4 Hong Kong (China) 582 5 Japan 579 6 Belgium 558 7 Netherlands 540 8 Slovak Republic 534 9 Hungary 532 10 Canada 531 19 United States 502 Science Rank Score 1 Taiwan 569 2 Singapore 568 3 Hungary 552 4 Japan 550 5 South Korea 549 6 Netherlands 545 7 Australia 540 8 Czech Republic 539 9 United Kingdom 538 10 Finland 535 18 United States 515 result from increases in the size of markets and firms are called economies of scale. Markets have increased in size over time, allowing firms to achieve production advantages associated with greater size. As firms expand their size and output, they are able to use larger, more productive equipment and employ methods of manufacturing and delivery that increase productivity. They also are better able to recoup substantial investments in developing new products and production methods. Examples: A large manufacturer of autos can use elaborate assembly lines with computerization and robotics, while smaller producers must settle for less advanced technologies using more labor inputs. Large pharmaceutical firms greatly reduce the average amount of labor (researchers, production workers) needed to produce each pill as they increase the number of pills produced. Accordingly, economies of scale result in greater real GDP and thus contribute to economic growth. Improved Resource Allocation Improved resource allocation means that workers over time have moved from low-productivity employment to high-productivity employment. Historically, much labor has shifted from agriculture, where labor productivity is low, to manufacturing, where it is quite high. More recently, labor has shifted away from some manufacturing industries to even higher productivity industries such as computer software, business consulting, and pharmaceuticals. As a result of such shifts, the average productivity of U.S. workers has increased. Also, discrimination in education and the labor market has historically deterred some women and minorities from entering high-productivity jobs. With the decline of such discrimination over time many members of those groups have shifted from low-productivity jobs to higherproductivity jobs. The result has been higher overall labor productivity and real GDP. Finally, we know from discussions in Chapter 6 that tariffs, import quotas, and other barriers to international trade tend to relegate resources to relatively unproductive pursuits. The long-run movement toward liberalized international trade through international agreements has improved the allocation of resources, increased labor productivity, and expanded real output, both here and abroad. (Key Question 6) mcc19359_ch17_308-324 28/08/03 18:40 Page 316 316 PA R T FIVE | Long-Run Perspectives and Macroeconomic Debates Other Factors Q U I C K R E V I E W 17.2 Several difficult-to-measure factors influence a nation’s rate of economic growth. The overall social-culturalpolitical environment of the United States, for example, has fostered economic growth. The market system that has prevailed in the United States since its founding has fostered many personal and corporate incentives that promote growth. The United States has also had a stable political system characterized by democratic principles, internal order, the right of property ownership, the legal status of enterprise, and the enforcement of contracts. Economic freedom and political freedom have been “growth-friendly.” Unlike some nations, there are virtually no social or moral taboos on production and material progress in the United States. The nation’s social philosophy has embraced material advance as an attainable and desirable economic goal. The inventor, the innovator, and the businessperson are accorded high degrees of prestige and respect in American society. Moreover, Americans have had positive attitudes toward work and risk taking, resulting in an ample supply of willing workers and innovative entrepreneurs. A flow of energetic immigrants has greatly augmented that supply. FIGURE • Improvements in labor productivity accounted for about two-thirds of increases in U.S. real GDP between 1990 and 2002; the use of more labor inputs accounted for the remainder. • Improved technology, more capital, greater education and training, economies of scale, and better resource allocation have been the main contributors to U.S. productivity growth and thus to U.S. economic growth. • Other factors that have been favorable to U.S. growth include reliance on the market system, a stable political system, a social philosophy that embraces material progress, an abundant supply of willing workers and entrepreneurs, and free-trade policies. The Productivity Acceleration: A New Economy? Figure 17.7 shows the growth of labor productivity (as measured by changes in the index of labor productivity) in the United States from 1973 to 2002, along with separate trend lines for 1973–1995 and 1995–2002. Labor productivity grew by an average of only 1.4 percent yearly 17.7 Growth of labor productivity in the United States, 1973–2002. U.S. labor productivity increased at an average annual rate of only 1.4 percent from 1973 to 1995. But between 1995 and 2002 it accelerated to an annual rate of 2.8 percent. Source: U.S. Bureau of Labor Statistics, www.bls.gov/. Productivity index, 1992 100 120 2.8% average growth 1995–2002 110 100 1.4% average growth 1973–1995 90 80 Actual 70 1973 1978 1983 1988 Year 1993 1998 2003 mcc19359_ch17_308-324 28/08/03 18:40 Page 317 CHAPTER over the 1973–1995 period. But productivity growth averaged 2.8 percent between 1995 and 2002. Many economists believe that this higher productivity growth resulted from a significant new wave of technological advance, coupled with global competition. Some economists say that the United States has achieved a New Economy—one with a higher projected trend rate of productivity growth and therefore greater potential economic growth than in the 1973–1995 period. This increase in productivity growth is important because real output, real income, and real wages are linked to labor productivity. To see why, suppose you are alone on an uninhabited island. The number of fish you can catch or coconuts you can pick per hour—your productivity—is your real wage (or real income) per hour. By increasing your productivity, you can improve your standard of living because greater output per hour means there are more fish and coconuts (goods) available to consume. So it is for the economy as a whole: Over long periods, the economy’s labor productivity determines its average real hourly wage. The economy’s income per hour is equal to its output per hour. Productivity growth therefore is its main route for increasing its standard of living. It allows firms to pay higher wages without lowering their business profits. As we demonstrated in this chapter’s Consider This box, even a seemingly small percentage change in productivity growth, if sustained over several years, can make a substantial difference as to how fast a nation’s standard of living rises. We know from the rule of 70 (Chapter 8) that if a nation’s productivity grows by 2.5 percent annually rather than 1.5, its standard of living will double in 28 years rather than 47 years. Reasons for the Productivity Acceleration Why has productivity growth increased relative to earlier periods? What is “new” about the New Economy? The Microchip and Information Technology The core element of the productivity speedup is an explosion of entrepreneurship and innovation based on the microprocessor, or microchip, which bundles transistors on a piece of silicon. Advocates of the New Economy liken the invention of the microchip to that of electricity, the automobile, air travel, the telephone, and television in importance and scope. The microchip has found its way into thousands of applications. It has helped create a wide array of new 17 | Economic Growth 317 products and services and new ways of doing business. Its immediate result was the pocket calculator, the bar-code scanner, the personal computer, the laptop computer, and more powerful business computers. But the miniaturization of electronic circuits also advanced the development of many other products such as cell phones and pagers, computer-guided lasers, deciphered genetic codes, global positioning equipment, energy conservation systems, Doppler radar, and digital cameras. Perhaps of greatest significance, the widespread availability of personal and laptop computers stimulated the desire to tie them together. That desire promoted rapid development of the Internet and all its many manifestations, such as business-to-household and business-tobusiness electronic commerce (e-commerce). The combination of the computer, fiber optic cable, wireless technology, and the Internet constitutes a spectacular advance in information technology, which has been used to connect all parts of the world. New Firms and Increasing Returns Hundreds of new start-up firms advanced various aspects of the new information technology. Many of these firms created more “hype” than goods and services and quickly fell by the wayside. But a number of firms flourished, eventually to take their places among the nation’s largest firms. Examples of those firms include Intel (microchips); Apple, Dell, and Gateway (personal computers); Microsoft, Oracle, and Intuit (computer software); Cisco Systems (Internet switching systems); America Online (Internet service provision); Yahoo and Google (Internet search engines); and Amazon.com (electronic commerce). There are scores more! Most of these firms were either “not on the radar” or “a small blip on the radar” 25 years ago. Today each of them has large annual revenue and employs thousands of workers. Successful new firms often experience increasing returns, which occur when a firm’s output increases by a larger percentage than the increase in its inputs (resources). For example, suppose that Techco decides to double the size of its operations to meet the growing demand for its services. After doubling its plant and equipment and doubling its workforce, say, from 100 workers to 200 workers, it finds that its total output has tripled from 8000 units to 24,000 units. Techco has experienced increasing returns; its output has increased by 200 percent, while its inputs have increased by only 100 percent. That is, its labor productivity has gone up from $80 ( 8000 units/100 workers) to $120 ( 24,000 units/200 workers). Increasing returns boost labor productivity, which, other things equal, lowers per-unit costs of production. These reductions in mcc19359_ch17_308-324 28/08/03 18:40 Page 318 318 PA R T FIVE | Long-Run Perspectives and Macroeconomic Debates costs resulting from larger firm size are called economies of scale. There are a number of sources of increasing returns and economies of scale for emerging firms: • More specialized inputs Firms can use more specialized and thus more productive capital and workers as they expand their operations. A growing new e-commerce business, for example, can purchase highly specialized inventory management systems and hire specialized personnel such as accountants, marketing managers, and system maintenance experts. • Spreading of development costs Firms can spread high product development costs over greater output. For example, suppose that a new software product costs $100,000 to develop and only $2 per unit to manufacture and sell. If the firm sells 1000 units of the software, its per-unit cost will be $102 [ ($100,000 $2000)1000], but if it sells 500,000 units, that cost will drop to only $2.20 [ ($100,000 $1 million)500,000]. • Simultaneous consumption Many of the products and services of the New Economy can satisfy many customers at the same time. Unlike a gallon of gas that needs to be produced for each buyer, a software program needs to be produced only once. It then becomes available at very low expense to thousands or even millions of buyers. The same is true of entertainment delivered on CDs, movies distributed on DVDs, and information disseminated through the Internet. • Network effects Software and Internet service becomes more beneficial to a buyer the greater the number of households and businesses that also buy them. When others have Internet service, you can send e-mail messages to them. And when they also have software that allows display of documents and photos, you can attach those items to your e-mail messages. These system advantages are called network effects, which are increases in the value of the product to each user, including existing users, as the total number of users rises. The domestic and global expansion of the Internet in particular has produced network effects, as have cell phones, pagers, palm computers, and other aspects of wireless communication. Network effects magnify the value of output well beyond the costs of inputs. • Learning by doing Finally, firms that produce new products or pioneer new ways of doing business experience increasing returns through learning by doing. Tasks that initially may have taken firms hours T A B L E 17.2 Examples of Cost Reductions from Technology in the New Economy • • • • • • • The cost of storing one megabit of information—enough for a 320-page book—fell from $5257 in 1975 to 17 cents in 1999. Prototyping each part of a car once took Ford weeks and cost $20,000 on average. Using an advanced 3-D object printer, it cut the time to just hours and the cost to less than $20. Studies show that telecommuting saves businesses about $20,000 annually for a worker earning $44,000—a saving in lost work time and employee retention costs, plus gains in worker productivity. Using scanners and computers, Weyerhaeuser increased the lumber yield and value from each log by 30 percent. Amoco has used 3-D seismic exploration technology to cut the cost of finding oil from nearly $10 per barrel in 1991 to under $1 per barrel today. Wal-Mart reduced the operating cost of its delivery trucks by 20 percent through installing computers, global positioning gear, and cell phones in 4300 vehicles. Banking transactions on the Internet cost 1 cent each, compared with $1.14 for face-to-face, pen-and-paper communication. Source: Compiled and directly quoted from W. Michael Cox and Richard Alm, “The New Paradigm,” Federal Reserve Bank of Dallas Annual Report, May 2000, various pages. may take them only minutes once the methods are perfected. Whatever the particular source of increasing returns, the result is higher productivity, which tends to reduce the per-unit cost of producing and delivering products. Table 17.2 lists a number of specific examples of cost reduction from technology in recent years. Global Competition The recent economy is characterized not only by information technology and increasing returns but also by heightened global competition. The collapse of the socialist economies in the late 1980s and early 1990s, together with the success of market systems, has led to a reawakening of capitalism throughout the world. The new information technologies have “shrunk the globe” and made it imperative for all firms to lower their costs and prices and to innovate in order to remain competitive. Free-trade zones such as NAFTA and the European Union (EU), along with trade liberalization through the World Trade Organization ( WTO), have also heightened competition internationally by removing trade protection from domestic firms. The larger geographic markets, in turn, have enabled the firms of the New Economy to expand beyond their national borders. mcc19359_ch17_308-324 10/17/2003 10:52AM Page 319 CHAPTER Macroeconomic Implications Stronger productivity growth and heightened global competition have a number of important implications for the macroeconomy. More Rapid Economic Growth Of greatest importance, the productivity speedup allows the economy to achieve a higher rate of economic growth. A glance back at Figure 17.3 will help make this point. If the shifts of the curves reflect annual changes in the old economy, then the New Economy would be depicted by an outward shift of the production possibilities curve beyond CD in Figure 17.3a, and a shift of the long-run aggregate supply curve farther to the right than ASLR2 in Figure 17.3b. When coupled with economic efficiency and increased total spending, the economy’s real GDP would rise by more than that shown. That is, the economy would achieve a higher rate of economic growth. In this view, the New Economy has a higher “safe speed limit” than the old economy because production capacity rises more rapidly. The New Economy can grow by, say, 4 percent, rather than 2 or 3 percent, each year without igniting demand-pull inflation. Increases in aggregate demand that in the past would have caused inflation do not cause inflation because they are buffered by faster productivity growth. Even when nominal wage increases rise to match the productivity increases, as they usually do, perunit production costs and therefore prices remain stable. Global competition in the New Economy also contributes to price stability. Proponents of the New Economy say that increasing returns and global competition explain why inflation remained mild as real GDP rapidly increased between 1995 and 2000. Low Natural Rate of Unemployment A low natural rate of unemployment (NRU) such as that of 1995–2000 (4 to 5 percent) may also be consistent with the New Economy. The new information technology reduces frictional unemployment by enabling workers and employers to quickly find each other. Growing Tax Revenues Finally, the faster economic growth enabled by the productivity speedup produces larger increases in personal income and, given tax rates, larger increases in government tax revenues. The quick and unexpected elimination of the Federal budget deficit during the last half of the 1990s resulted largely from the higher rates of growth of real GDP. In 1995 the Federal government had a budget deficit of $160 billion; in 2000 it had a budget surplus of $167 billion. 17 | Economic Growth 319 A caution: Those who champion the idea of a New Economy emphasize that it does not mean that the business cycle is dead. Indeed, the economy slowed in the first two months of 2001 and receded over the following eight months of that year. The New Economy is simply one for which the trend lines of productivity growth and economic growth are steeper than they were in the preceding two decades. Real output may periodically deviate below and above those trend lines. Skepticism about Permanence Although most macroeconomists have revised their forecasts for long-term productivity growth upward, at least slightly, others are still skeptical and urge a “wait-andsee” approach. Skeptics acknowledge that the economy has experienced a rapid advance of new technology, many new firms have experienced increasing returns, and global competition has increased. But they wonder if these factors are sufficiently profound to produce a 10- to 15-year period of substantially higher rates of productivity growth and real GDP growth. The higher rates of productivity and real GDP growth between 1995 and 2002 are consistent with a long-lived New Economy. Unfortunately, they are also consistent with a rapid short-run economic expansion fueled by an extraordinarily brisk rise in consumption and investment spending. Such economic booms raise productivity by increasing real output faster than employment (labor inputs), but they are unsustainable over longer periods. Skeptics point out that productivity surged between 1975 and 1978 and between 1983 and 1986 but in each case soon reverted to its lower long-run trend. For a time, economic expansions need not create inflation, as long as wage growth does not exceed the growth of productivity. But economic booms eventually create shortages, which produce inflationary pressures. Even industries that once had decreasing or constant costs can begin to experience rising costs when the pool of available workers dries up. The excessive demand that is causing the boom eventually raises all prices, including the price of labor. Rising inflation or the threat of rising inflation prompts the Federal Reserve to engineer increases in interest rates. For example, the Fed raised the Federal funds interest rate from 4.75 to 6 percent in a series of steps in 1999 and 2000. By reducing investment spending, the higher interest rates dampen some of the inflationary pressure but may inadvertently slow the economy too much, causing recession. In any event, productivity and output growth stall. The higher trend line of productivity inferred from the mcc19359_ch17_308-324 10/17/2003 10:52AM Page 320 320 PA R T FIVE | Long-Run Perspectives and Macroeconomic Debates short-run spurt of productivity proves to be an illusion. Only by looking backward over long periods can economists distinguish the start of a new long-run secular trend from a shorter-term boost in productivity related to the business cycle. What Can We Conclude? Given the different views on the New Economy, what should we conclude? Perhaps the safest conclusions are these: • We should be pleased with the exceptional performance of the economy between 1995 and 2000, for its own sake, whether or not it represents a New Economy. These were remarkable times for the U.S. economy. • The prospects for a more rapid long-run trend of productivity growth are good (see Global Perspective 17.2). Studies indicate that productivity advance related to information technology has spread to a wide range of industries, including services. Even in the G L O B A L P E R S P E C T I V E 17.2 Growth Competitiveness Index The World Economic Forum annually compiles a growth competitiveness index, which uses various factors (such as innovativeness, effective transfer of technology among sectors, efficiency of the financial system, rates of investment, and degree of integration with the rest of the world) to measure the ability of a country to achieve economic growth over time. Here is its latest top 10 list: Country Growth Competitiveness Ranking, 2002 United States 1 Finland 2 Taiwan 3 Singapore 4 Sweden 5 Switzerland 6 Australia 7 Canada 8 Norway 9 Denmark 10 Source: World Economic Forum, www.weforum.org/. • recession year 2001 and in 2002, when the economy was sluggish, productivity growth remained strong. Specifically, it averaged about 3 percent over these two years. Time will tell. It will be several more years before economists can declare the recent productivity acceleration a long-term reality. (Key Question 9) Q U I C K R E V I E W 17.3 • Over long time periods, labor productivity growth determines an economy’s growth of real wages and its standard of living. • Many economists believe that the United States has achieved a New Economy of faster productivity growth and higher rates of economic growth. • The productivity acceleration is based on rapid technological change in the form of the microchip and information technology, increasing returns and lower per-unit costs, and heightened global competition that helps hold down prices. • Faster productivity growth means the economy has a higher “economic speed limit”: It can grow more rapidly than previously without producing inflation; the economy has a lower natural rate of unemployment; and it generates more rapid increases in tax revenues. Nonetheless, many economists caution that it is too early to determine whether the New Economy is a lasting long-run trend or a fortunate short-lived occurrence. Is Growth Desirable and Sustainable? Economists usually take for granted that economic growth is desirable and sustainable. But not everyone agrees. The Antigrowth View Critics of growth say industrialization and growth result in pollution, global warming, ozone depletion, and other environmental problems. These adverse spillover costs occur because inputs in the production process reenter the environment as some form of waste. The more rapid our growth and the higher our standard of living, the more waste the environment must absorb—or attempt to absorb. In an already wealthy society, further growth usually means satisfying increasingly trivial wants at the cost of mounting threats to the ecological system. Critics of growth also argue that there is little compelling evidence that economic growth has solved mcc19359_ch17_308-324 28/08/03 18:40 Page 321 CHAPTER sociological problems such as poverty, homelessness, and discrimination. Consider poverty: In the antigrowth view, American poverty is a problem of distribution, not production. The requisite for solving the problem is commitment and political courage to redistribute wealth and income, not further increases in output. Antigrowth sentiment also says that while growth may permit us to “make a better living,” it does not give us “the good life.” We may be producing more and enjoying it less. Growth means frantic paces on jobs, worker burnout, and alienated employees who have little or no control over decisions affecting their lives. The changing technology at the core of growth poses new anxieties and new sources of insecurity for workers. Both high-level and low-level workers face the prospect of having their hard-earned skills and experience rendered obsolete by an onrushing technology. High-growth economies are high-stress economies, which may impair our physical and mental health. Finally, critics of high rates of growth doubt that they are sustainable. The planet Earth has finite amounts of natural resources available, and they are being consumed at alarming rates. Higher rates of economic growth simply speed up the degradation and exhaustion of the earth’s resources. In this view, slower economic growth that is sustainable is preferable to faster growth. In Defense of Economic Growth The primary defense of growth is that it is the path to the greater material abundance and higher living standards desired by the vast majority of people. Rising output and incomes allow people to buy more education, recreation, and travel, more medical care, closer communications, more skilled personal and professional services, and better-designed as well as more numerous products. It also means more art, music, and poetry, theater, and drama. It can even mean more time and resources devoted to spiritual growth and human development.1 Growth also enables society to improve the nation’s infrastructure, enhance the care of the sick and elderly, provide greater access for the disabled, and provide more police and fire protection. Economic growth may be the only realistic way to reduce poverty, since there is little political support for greater redistribution of income. The 1 Alice M. Rivlin, Reviving the American Dream (Washington, D.C.: Brookings Institution, 1992), p. 36. 17 | Economic Growth 321 way to improve the economic position of the poor is to increase household incomes through higher productivity and economic growth. Also, a no-growth policy among industrial nations might severely limit growth in poor nations. Foreign investment and development assistance in those nations would fall, keeping the world’s poor in poverty longer. Economic growth has not made labor more unpleasant or hazardous, as critics suggest. New machinery is usually less taxing and less dangerous than the machinery it replaces. Air-conditioned workplaces are more pleasant than steamy workshops. Furthermore, why would an end to economic growth reduce materialism or alienation? The loudest protests against materialism are heard in those nations and groups that now enjoy the highest levels of material abundance! The high standard of living that growth provides has increased our leisure and given us more time for reflection and self-fulfillment. Does growth threaten the environment? The connection between growth and environment is tenuous, say growth proponents. Increases in economic growth need not mean increases in pollution. Pollution is not so much a by-product of growth as it is a “problem of the commons.” Much of the environment—streams, lakes, oceans, and the air—is treated as “common property,” with no or insufficient restrictions on its use. The commons have become our dumping grounds; we have overused and debased them. Environmental pollution is a case of spillover or external costs, and correcting this problem involves regulatory legislation, specific taxes (“effluent charges”), or market-based incentives to remedy misuse of the environment. Those who support growth admit there are serious environmental problems. But they say that limiting growth is the wrong solution. Growth has allowed economies to reduce pollution, be more sensitive to environmental considerations, set aside wilderness, create national parks and monuments, and clean up hazardous waste, while still enabling rising household incomes. Is growth sustainable? Yes, say the proponents of growth. If we were depleting natural resources faster than their discovery, we would see the prices of those resources rise. That has not been the case for most natural resources; in fact, the prices of most of them have declined. And if one natural resource becomes too expensive, another resource will be substituted for it. Moreover, say economists, economic growth has to do with the expansion and application of human knowledge and information, not of extractable natural resources. In this view, economic growth is limited only by human imagination. mcc19359_ch17_308-324 28/08/03 18:40 Page 322 L A S T W O R D Women and Economic Growth A Large Increase in the Labor-Force Participation Rate of Women Has Shifted the U.S. Production Possibilities Curve Outward and Contributed to Economic Growth. One of the major labor market trends of the past half-century in the United States has been the substantial rise in the number of women working in the paid workforce.Today 60 percent of women work full-time or part-time in paid jobs, compared to only 40 percent in 1965. This trend has greatly contributed to U.S. economic growth. There are many reasons for the surge of women to the workforce. Women’s Rising Wage Rates Over recent years, women have greatly increased their productivity in the workplace, mostly by becoming better educated and professionally trained. As a result, they can earn higher wages. Because those higher wages have increased the opportunity costs—the forgone wage earnings—of staying at home, women have substituted employment in the labor market for more “expensive” traditional home activities. This substi- tution has been particularly pronounced among married women. Expanded Job Access Greater access to jobs is a second factor increasing the employment of women. Service industries—teaching, nursing, and clerical work, for instance—that traditionally have employed mainly women have expanded in the past several decades.Also, the population in general has shifted from farms and rural regions to urban areas, where jobs for women are more abundant and more geographically accessible.The decline in the average length of the workweek and the increased availability of part-time jobs have also made it easier for women to combine labor market employment with child-rearing and household activities. Also, antidiscrimination laws and enforcement efforts have reduced barriers that previously discouraged or prevented women from taking traditional male jobs such as managers, lawyers, professors, and physicians. More jobs are “open” to women today than a half-century ago. S U M M A RY 1. Economic growth—measured as either an increase in real output or an increase in real output per capita—increases material abundance and raises a nation’s standard of living. 2. The supply factors in economic growth are (a) the quantity and quality of a nation’s natural resources, (b) the quantity and quality of its human resources, (c) its stock of capital facilities, and (d) its technology. Two other factors—a sufficient level of aggregate demand and economic efficiency—are necessary for the economy to realize its growth potential. 3. The growth of production capacity is shown graphically as an outward shift of a nation’s production possibilities curve or as a rightward shift of its long-run aggregate supply curve. Growth is realized when total spending rises sufficiently to match the growth of production capacity. tivity of labor. The increases in productivity have resulted mainly from technological progress, increases in the quantity of capital per worker, improvements in the quality of labor, economies of scale, and an improved allocation of labor. 6. Over long time periods, the growth of labor productivity underlies an economy’s growth of real wages and its standard of living. 7. Productivity rose by 2.8 percent annually between 1995 and 2002, compared to 1.4 percent annually between 1973 and 1995. Some economists think this productivity acceleration will be long-lasting and is reflective of a New Economy— one of faster productivity growth and greater noninflationary economic growth. 4. Between 1950 and 2000 the annual growth rate of real GDP for the United States averaged about 3.5 percent; the annual growth rate of real GDP per capita was about 2.3 percent. 8. The New Economy is based on (a) rapid technological change in the form of the microchip and information technology, (b) increasing returns and lower per-unit costs, and (c) heightened global competition that holds down prices. 5. U.S. real GDP has grown partly because of increased inputs of labor and primarily because of increases in the produc- 9. The main sources of increasing returns in the New Economy are (a) use of more specialized inputs as firms 322 mcc19359_ch17_308-324 10/17/2003 10:52AM Page 323 Changing Preferences and Attitudes Women collectively have changed their preferences from household activities to employment in the labor market. Many find personal fulfillment in jobs, careers, and earnings, as evidenced by the huge influx of women into law, medicine, business, and other professions. More broadly, most industrial societies now widely accept and encourage labor-force participation by women, including those with very young children. Today about 65 percent of American mothers with preschool children participate in the labor force, compared to only 30 percent in 1970. More than half return to work before their youngest child has reached the age of 2. Declining Birthrates There were 3.8 lifetime births per woman in 1957 at the peak of the baby boom.Today the number is less than 2. This marked decline in the size of the typical family, the result of changing lifestyles and the widespread availability of birth control, has freed up time for greater labor-force participation by women. Not only do women now have fewer children; their children are spaced closer together in age. Thus women who leave their jobs during their children’s early years can return to the labor force sooner. Higher wage rates have also been at work. On average, women with relatively high wage earnings have fewer children than women with lower earnings. The opportunity cost of children—the income sacrificed by not being employed—rises as wage earnings rise. In the language of economics, the higher “price” associated with children has reduced the “quantity” of children demanded. grow, (b) the spreading of development costs, (c) simultaneous consumption by consumers, (d) network effects, and (e) learning by doing. Increasing returns mean higher productivity and lower per-unit production costs. 10. Those who champion the New Economy say that it has a lower natural rate of unemployment than did the old economy, can grow more rapidly without producing inflation, and generates higher tax revenues because of faster growth of personal income. 11. Skeptics of the New Economy urge a wait-and-see approach. They point out that surges in productivity and real GDP growth have previously occurred during vigorous T E R M S A N D Rising Divorce Rates Marital instability,as evidenced by high divorce rates, may have motivated many women to enter and remain in the labor market. Because alimony and child-support payments are often erratic or nonexistent, the economic impact of divorce on nonworking women may be disastrous. Most nonworking women enter the labor force for the first time following divorce. And many married women—perhaps even women contemplating marriage—may have joined the labor force to protect themselves against the financial difficulties of potential divorce.Also, it is plausible that the greater economic independence of women has allowed them to abandon unfulfilling marriages. Slower Growth of Male Wages The earnings of many low-wage and middle-wage male workers grew slowly or even fell in the United States over the past three decades. Many wives may have entered the labor force to ensure the rise of household living standards. The median income of couples with children grew 25 percent between 1969 and 1996. Without the mothers’ incomes, that growth would have been only 2 percent. A related issue is that couples of all income levels may be concerned about their family incomes compared to those of other families. So the entry of some women into the labor force may have encouraged still other women to enter in order to maintain their families’ relative standards of living. Taken together, these factors have produced a rapid rise in the presence of women workers in the United States. This increase in the quantity of resources and their enhanced productivity have contributed greatly to U.S. economic growth. economic expansions but do not necessarily represent longlived trends. 12. Critics of rapid growth say that it adds to environmental degradation, increases human stress, and exhausts the earth’s finite supply of natural resources. Defenders of rapid growth say that it is the primary path to the rising living standards nearly universally desired by people, that it need not debase the environment, and that there are no indications that we are running out of resources. Growth is based on the expansion and application of human knowledge, which is limited only by human imagination. C O N C E P T S economic growth labor productivity human capital start-up firms supply factors labor-force participation rate economies of scale increasing returns demand factor growth accounting New Economy network effects efficiency factor infrastructure information technology learning by doing 323 mcc19359_ch17_308-324 28/08/03 18:40 Page 324 324 PA R T FIVE | Long-Run Perspectives and Macroeconomic Debates S T U DY Q U E S T I O N S 1. Key Question What are the four supply factors of economic growth? What is the demand factor? What is the efficiency factor? Illustrate these factors in terms of the production possibilities curve. 2. Suppose that Alpha and Omega have identically sized working-age populations but that annual hours of work are much greater in Alpha than in Omega. Provide two possible explanations. 3. Suppose that work hours in New Zombie are 200 in year 1 and productivity is $8. What is New Zombie’s real GDP? If work hours increase to 210 in year 2 and productivity rises to $10, what is New Zombie’s rate of economic growth? 4. What is the relationship between a nation’s production possibilities curve and its long-run aggregate supply curve? How does each relate to the idea of a New Economy? 5. Key Question Between 1990 and 2002 the U.S. price level rose by about 38 percent while real output increased by about 41 percent. Use the aggregate demand–aggregate supply model to illustrate these outcomes graphically. 6. Key Question To what extent have increases in U.S. real GDP resulted from more labor inputs? From higher labor productivity? Rearrange the following contributors to the growth of real GDP in order of their quantitative importance: economies of scale, quantity of capital, improved resource allocation, education and training, technological advance. 7. True or false? If false, explain why. a. Technological advance, which to date has played a relatively small role in U.S. economic growth, is destined to play a more important role in the future. b. Many public capital goods are complementary to private capital goods. c. Immigration has slowed economic growth in the United States. 8. Explain why there is such a close relationship between changes in a nation’s rate of productivity growth and changes in its average real hourly wage. 9. Key Question Relate each of the following to the New Economy: a. The rate of productivity growth b. Information technology c. Increasing returns d. Network effects e. Global competition 10. Provide three examples of products or services that can be simultaneously consumed by many people. Explain why labor productivity greatly rises as the firm sells more units of 11. 12. 13. 14. 15. 16. the product or service. Explain why the higher level of sales greatly reduces the per-unit cost of the product. What is meant when economists say that the U.S. economy has “a higher safe speed limit” than it had previously? If the New Economy has a higher safe speed limit, what explains the series of interest-rate hikes engineered by the Federal Reserve in 1999 and 2000? Productivity often rises during economic expansions and falls during economic recessions. Can you think of reasons why? Briefly explain. (Hint: Remember that the level of productivity involves both levels of output and levels of labor input.) ( Last Word) Which two of the six reasons listed in the Last Word do you think are the most important in explaining the rise in participation of women in the U.S. workplace? Explain your reasoning. How does the rising labor-force participation rate of women relate to economic growth? Web-Based Question: U.S. economic growth—what are the latest rates? Go to the Bureau of Economic Analysis website, www.bea.gov, and use the data interactivity feature to find National Income and Product Account Table S.1. What are the quarterly growth rates (annualized) for the U.S. economy for the last six quarters? Is the average of those rates above or below the long-run U.S. annual growth rate of 3.5 percent? Expand the range of years, if necessary, to find the last time real GDP declined in two or more successive quarters. What were those quarters? Web-Based Question: What’s up with productivity? Visit the Bureau of Labor Statistics website, www.bls.gov. In sequence, select Productivity and Costs, Get Detailed Statistics, and Most Requested Statistics to find quarterly growth rates (annualized) for business output per hour for the last six quarters. Is the average of those rates higher or lower than the 1.4 percent average annual growth rate of productivity during the 1973–1995 period? Web-Based Question: Productivity and technology— examples of innovations in computers and communications Recent innovations in computers and communications technologies are increasing productivity. Lucent Technologies (formerly Bell Labs), at www.lucent.com/ minds/discoveries, provides a timeline of company innovations over the past 80 years. Cite five technological “home runs” (for example, the transistor in 1947) and five technological “singles” (for example, free space optical switching in 1990). Which single innovation do you think has increased productivity the most? List two innovations since 1990. How might they boost productivity?